Is it worth it to buy a ‘longevity annuity’? Probably not

By Glenn Ruffenach

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Would-be retirees will soon be able to buy “longevity annuities” for their savings plans. These products can help guard against running out of money in later life – as long as you recognize their shortcomings.

New federal tax rules, published in July, allow individuals to purchase so-called longevity policies in their individual retirement accounts and 401(k) plans. Insurers will likely begin introducing the products in September.

But as Anne Tergesen explained recently in the Sunday edition of The Wall Street Journal, you need to weigh several issues before taking the plunge.

Some background: A longevity annuity – like a traditional immediate annuity – allows you to convert a lump sum into a pension-like stream of income in retirement. But longevity policies require holders to pick an income start date that typically ranges from one to 40 or more years in the future.

Why the delay? Because when payments begin, they are larger than what you would get with a regular annuity.

For instance, a 55-year-old man paying $100,000 for an immediate annuity can get about $5,800 a year for life, according to ImmediateAnnuities.com. But with a longevity policy that starts payments at age 75, the annual payout would be just over $24,000. And if he waits until age 85 to start collecting, he would receive almost $82,000 a year, according to New York Life Insurance.

In July, the Treasury Department granted those who purchase longevity annuities relief from rules involving “required minimum distributions” (the amount you must withdraw from retirement savings plans after reaching age 70 ½). The new provisions: Buyers of longevity annuities inside a retirement savings plan must begin collecting income by age 85 and put no more than 25% of their traditional-IRA and 401(k) money into such an annuity, up to an overall maximum of $125,000.

As such, someone who uses $100,000 of a $400,000 IRA to buy a longevity annuity can calculate RMDs only on the remaining $300,000, says Ed Slott, an IRA expert in Rockville Centre, N.Y. (Because Roth accounts aren’t subject to RMDs during the owner’s lifetime, the new rules on longevity annuities – including caps on purchases – don’t apply to them.)

The downsides? As with most immediate annuities, you must surrender your principal to the insurer. If you die before payouts begin, the insurer keeps the money. If you are willing to accept a lower income, you can provide a death benefit for your heirs.

Michael Kitces, director of planning research at Pinnacle Advisory Group in Columbia, Md., suggests that, before buying a longevity annuity, you should first defer Social Security benefits, ideally to age 70. If that doesn’t create sufficient income for later life, he says, a longevity policy might make sense – but it’s best if you take a pass on the death benefit.

Why? A 65-year-old couple who buys a longevity annuity that begins payments at age 85 will realize an internal rate of return of 5.9% – before inflation – on that investment, assuming one spouse lives to 100. Add a death benefit, and the return falls to 5.4%.

Finally, to protect your investment, work with insurers with triple-A or double-A ratings of claims-paying ability – and keep purchases below your state guaranty fund’s limit on coverage. To find links to that limit, go to www.nolhga.com.

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About Encore

Encore looks at the changing nature of retirement, from new rules and guidelines for financial security to the shifting identities, needs and priorities of people saving for and living in retirement. Our lead blogger is editor Matthew Heimer, and frequent contributors include editor Amy Hoak, writer Catey Hill, and MarketWatch columnists Elizabeth O’Brien, Robert Powell and Andrea Coombes. Encore also features regular commentary from The Wall Street Journal retirement columnists Glenn Ruffenach and Anne Tergesen and the Director of the Center for Retirement Research at Boston College, Alicia H. Munnell.